Equity ratio (solidity)

The formula

• ER = 100 · E / A

E is the shareholders’ equity and A the total assets. The percentage is the share of everything the company owns that is paid for with the owners’ money; the rest is paid for with somebody else’s.

A worked example

Equity of 400,000 and total assets of 1,000,000: ER = 100 · 400,000 / 1,000,000 = 40%. The lenders and suppliers have financed the other 60%. A company that wants an equity ratio of 40% with 1,500,000 of assets needs 600,000 of equity.

What the number says

A high equity ratio means the company can absorb losses before the lenders are at risk and can borrow more if it needs to; a low one means the opposite. It is the long-term solvency figure, where the current ratio is the short-term one. Industries differ: a bank runs on a few per cent by design, a consultancy on much more.

The same fact as debt-to-equity

Assets are equity plus debt, so the equity ratio and the debt-to-equity ratio are one balance sheet read two ways: an equity ratio of 40% is a debt-to-equity of 60 / 40 = 1.5. Which one a report uses is habit.

Common mistakes

• Using the book value as if it were the market value. Assets written down to little, or land carried at an old price, move the ratio either way.
• Forgetting untaxed reserves. Where the accounts carry them, the equity part of them is usually added to E; say so if it is.
• Reading one year. A ratio that falls year after year says more than its level.

Frequently asked questions